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Posted by
MrJames
on 2007-12-10

Aspiring entrepreneurs be warned. Venture capitalists will provide money for your idea, but they often walk away with most of the value, especially if you are not careful. Like an amateur sitting at a table of professionals, the cards are stacked against your success, so be prepared. Know the game.

Here are some anecdotal facts. There are five times as many people working in venture capital as there are CEO's that are funded each year (~16,500 vs ~3,000). The average venture funded CEO is fortunate to make 1/10th to 1/20th the return on exit as the venture capitalists. Just the legal fees on a later stage deal will run $50,000 or more per party involved, and the venture capitalists always flip the bill, directly or indirectly. Who do the lawyers work for again"

No matter how nice, no matter how fair, and no matter how genuine a venture capitalist appears, you are being out-smarted, out-lawyered, and out-maneuvered the second you sit down and ask for money. The first step in winning is to understand their motivations: (1) control, (2) risk, and (3) opportunity, in that order. Let's take a look at all three.

The entirety of a venture investment centers around control, and control takes many forms: control of the board, control of the voting, control of the investment capital, and, most importantly, control of the management. Venture capitalists are "control freaks," and the psychology of control is embedded in nearly every aspect of the deal legal structure. Assume that most financing terms, from Board meeting frequency to protective provisions have some origin in control, and analyze them as such. Ask yourself: in good times and in bad, how do these terms affect my behavior as a CEO" For example, did Google really need to have 14 Board meetings in one year... ever"

Venture capitalists are excellent at managing risk. It is assumed that at most venture investments fail, but approximately one in ten succeed. Following this simplistic logic, a venture capitalist would need to make at least $10 from every $1 invested in a success to recover from the 9 losses. Now, not every deal is a total loss, but a lot are. Complex protections are inevitably put in place. Let's look at a common scenario: a company receives $10 MM for 50% of the stock in a participating preferred with a 2x liquidation preference. The company sells for $25 MM right after the investment. How much does the founding team make" Nothing. The "50%" is legalese.

Venture capitalists are not very good at spotting opportunities, or they might have better odds than 1 in 10. However, they are very good at "managing" opportunities as a result. Here are some examples. Venture capitalists do not say "no" (for risk of losing an opportunity). They postpone meetings until you are achieving success, and they flock around markets with success stories. Ever wonder why a venture capitalist calls you out of the blue asking about your company" It's probably because a competitor is succeeding. Every wonder what "demonstrate traction" actually means" It means a nine figure IPO or liquidity event in your sector. Your dream is just potential, and you will be held on the sidelines until "the time is right" for the venture capitalists to make money.

The irony is that the venture capital behavior is largely a response to other abuses by CEO's. At this point, however, the venture capitalists have gone too far. The opportunities in building a venture funded start-up are gone for the great entrepreneurs. It simply makes more sense to go it alone.

Venture capitalists tend to invest around trends in the various investment sectors that they cover, which makes sense from a capital concentration standpoint in a given sector. You may be pitching a business that is not related to the current trends, since the trends change every few months, but it is important to understand them. The partners and associates will be actively researching the trends, so a lot of the questions in a pitch meeting will be influenced by the current trends. Questions that may appear irrelevant to you as an entrepreneur may be influenced by the current sector trends. Be prepared.

As it is becoming harder to raise capital from venture capitalists, existing investors are facing situations where they need to lead new rounds in their own portfolio companies. This presents a big problem for valuations, especially if an investor only has convertible debt. Recently, I've heard a few stories about existing investors promising to lead a round, then pulling out or dramatically changing the terms. Worse, investors will sometimes string you along with a singed term sheet until you are out of cash, and then completely change the deal to take control.

Here are some tips if you think that you are going to need money in the next 18 months.

Know where insiders stand: You need to know where if your insiders will participate or lead a new financing event, and you should also ask them what their specific expectations are for your company performance. Assume that any inside round will be flat.

Pursue other options: Even if your insiders agree to lead a round, you should do your best to have an alternative financing option available. You will never get a fair price for your equity from insiders, since they are pricing, selling, and buying the equity at the same time and since they see all the warts and bruises.

Raise now, not later: Don't wait to raise money. Raising will take twice as long and will be twice as hard in this market. Try to raise enough capital to operate for more than 48 months, if you can.

When in doubt, do debt: If things are not moving fast enough and you have only three or four months worth of cash left, press your existing investors to do a convertible debt round that will give you eight to twelve months of low growth operating capital.

Insider sheet to attract outsiders: If everything else is failing, you may want to have your insiders draft a term sheet with a lot of room for new investors to participate. It's often easier to find outside investors with a "legitimate" term sheet in hand.

By diligently negotiating the cap on investor legal fees, you will dramatically accelerate both the diligence and the closing timeline. Most investors will easily agree to a cap of $25,000 to $50,000, and you can be sure that all of this money (and time) get chewed through on both sides. Factoring in your own legal costs, you could be looking at a $50,000 to $100,000 deal that takes between two and four months to close.

However, negotiate hard when you get a term sheet to cap the investor legal expenses at $10,000. With fees at this level, all of the work needs to go into drafting documents versus negotiating detailed terms. The lawyers themselves will feel pressure to close faster, rather than work endlessly to reach the agreed cap level. All in all, you will be looking at a cleaner deal that closes in two weeks to one month.

As a CEO I make sure I periodically look back at my 'fuck ups' and learn from them. Theres been a few along the way, some small, a couple a little bigger, so I wanted to share one here.

Funding

Raising money took way longer than I expected. The search didn't take too long.. the deal completion tooks months and put enormous strain on our resources. Both financially as we bridged our way to funds and on our time and focus. Raising money is a major distraction from running your day to day business. I estimated 2 months to complete the deal. Its taken almost 5 and stretched us thin as well as pulled my attention away from what I am here for - building the business. I'm lucky, we raised money.. but now I get 80+ hour weeks making up lost ground in business development as well as the backlash of robbing Peter to pay Paul the past couple months.

Lesson: Assume 6 - 9 months to search, obtain and close funding and make sure you have both the financial and human resources to run and grow your business during the deal cycle.

Posted by
Mr. Smith
on 2009-06-26

Getting a meeting with an investor is hard these days, but it can be done. Once in a meeting, here are five strategies to make the meeting go well:

>> STICK TO THE FACTS
Sell your idea on factual information only. Avoid adjectives and superlatives whenever possible. You do not have the best, the most, or the greatest anything. Most investors see 2,500 deals per year. They need basic information to determine interest. Suspect information is a red flag, and it only takes one red flag for an investor to lose interest.

>> KEEP YOUR PITCH SHORT
You should be able to explain your company in 10 slides that take about 20 minutes to present. If you want to succeed, then videotape yourself giving the pitch. Watch the video and write down everything that you want to improve in a list. Repeat this process until you are happy with the results. At the end of your pitch, say: "does anyone have questions that I can help you with?" The shorter your pitch, the more questions that will you have, and more questions are good.

>> ANSWER EVERY QUESTION BRIEFLY
Answer every question with one or two sentences and with as few words as possible. Uncomfortable silence is a tool that you can use to elicit another question. If you do not have or know an answer, say: "I don't recall the answer to that off the top of my head, can I look it up in my files and get back to you through email." Questions are an excellent sign of interest and engagement. When an investor gets into 'question mode,' they usually have a series of 5 to 10 questions that they need answered quickly to evaluate the opportunity. You are doing well in a pitch when the investors are talking.

>> ASK FOR FEEDBACK AND TAKE NOTES
Make sure to leave a few minutes to collect feedback. Ask the investors, 'do you have any recommendations for the business?' Have a pen and paper out, and write down everything that the investors say. It's a common courtesy to take notes, and it is expected. After an investor says something, say 'thank you.' Do not get defensive. Nothing sours a relationship faster than getting into a debate.

>> BE AN EXPERT IN YOUR INDUSTRY
You should read every recent blog post and know about every key development in the primary industry and all related industries to your idea. It is very likely that an investor will have seen and researched a very similar idea within the last 45 days. It is also very likely that this investor will ask you about mundane developments or other companies in the field as a test of your knowledge and to show off their own expertise. When confronted, you say, 'Yes, I was aware of that. Thank you.' This will lead to more questions.

As a closing point, be confident and assured. A common misperception is that a deal can be done in one meeting. It usually can't. So, the goal of any meeting should be (1) to get another meeting and (2) to specify follow-up items.

Posted by
Bruce Kasanoff
on 2009-01-27

In the middle of trying to launch a start-up (The Goal Mine), the deepening downturn has pulled me back to a practice (Now Possible) that has become more timely than ever: re-positioning companies.

As I look around the entrepreneurial landscape, what surprises me is how little substantive re-positioning has occurred... yet. The world has shifted, dramatically. The rules have changed. And yet most firms are pretty much still pitching the business model they developed before last fall. 95% of the time, that's not going to work.

This new world creates its own opportunities. All is not gloom and doom, unless you fail to acknowledge how much the rules have changed. Rents are going down. Lots of talent is available. People are willing to take chances (largely because they have no choice.) But at the same time, everyone has both hands on their wallet.

One thing to keep in mind: hope is not a strategy. Hoping you'll get funding and find customers even though you did not change your positioning, well, that's not much of strategy. Basically, the entire world is taking a 50% pay cut. So what do you do differently?